Housing Risk

The mortgage industry is still on shaky ground, warn Profs. Nancy Wallace and Richard Stanton

Housing Risk
Nonbanks—a category of independent lenders that are more lightly regulated and more financially fragile than banks—now account for half of all mortgages, up from 20 percent in 2007.

Despite tough banking rules enacted after last decade’s housing crash, the mortgage market again faces the risk of a meltdown that could endanger the U.S. economy, warn Professors Richard Stanton and Nancy Wallace in a paper co-authored by Federal Reserve economists. The threat reflects a boom in nonbank mortgage companies, a category of independent lenders that are more lightly regulated and more financially fragile than banks—and whose share of the U.S. mortgage market has ballooned.

“If these firms go out of business, the mortgage market shuts down, and that has dire implications for the overall health of the economy,” says Stanton.

During the housing bust, nonbank lenders failed in droves as home prices fell and borrowers stopped making payments, fueling a wider financial crisis. Yet when banks dramatically cut back home loans after the crisis, nonbank mortgage companies stepped back into the fray.

Now, nonbanks account for half of all mortgages, up from 20 percent in 2007. Their share of mortgages with explicit government backing is even higher: nonbanks originate about 75 percent of loans guaranteed by the Federal Housing Administration or the U.S. Department of Veterans Affairs.

Nonbank lenders are regulated by a patchwork of state and federal agencies that lack the resources to adequately oversee them, so risk can easily build unnoticed. While the Federal Reserve lends money to banks in a pinch, it does not do the same for independent mortgage companies.

Unlike banks, independent mortgage companies have little capital of their own and scant access to cash in an emergency. They rely on a type of short-term funding known as warehouse lines of credit, usually provided by larger commercial and investments banks. Stanton and Wallace provide the first public tabulation of the scale of this lending. There was a $34 billion commitment on warehouse loans at the end of 2016, up from $17 billion at the end of 2013. That translates to about $1 trillion in short-term warehouse loans funded over the course of a year, they calculated. If the economy falters or if banks extending credit to mortgage lenders cut them off, many of these companies would find themselves without recourse.

If the market collapses, taxpayers would potentially be on the hook for losses posted by failed mortgage companies, primarily due to the mortgage-backed-security guarantees provided by Ginnie Mae and the government-sponsored agencies Fannie Mae and Freddie Mac. Mortgage companies are supposed to bear the losses if these securitized loans go bad. But if those companies go under, the government “will probably bear the majority of the increased credit and operational losses,” the paper says. Ginnie Mae is especially vulnerable—almost 60 percent of the dollar volume of the mortgages it guarantees comes from nonbank lenders.

What’s more, vulnerable communities would be hit hardest. In 2016, nonbank lenders made 64 percent of the home loans extended to Black and Latino borrowers and 58 percent of the mortgages to homeowners living in low- or moderate-income tracts, the paper reports.